A Tip from the Pros: Don&rsquo;t Look Back

There has been a broad divergence between what individual investors and money managers have been doing with their investments, and it's time to learn some lessons from the pros, say Russel Kinnel of Morningstar FundInvestor.

At the 2011 Morningstar Investment Conference, we heard bearish cases against US Treasuries from PIMCO’s Bill Gross, JP Morgan’s Bill Eigen, and GMO’s Ben Inker. Instead, many managers said you should buy US equities based on their dividends and earnings prospects.

Yet, just as the conference was wrapping up, our latest fund flow report revealed taxable-bond funds had a massive inflow of $20 billion in May, while US-stock funds were redeemed to the tune of $3.8 billion.

Why were individual investors doing the opposite of the professional investors we heard from at the conference? The short answer is individual investors are looking in the rearview mirror, and the pros are looking forward.

Why buy taxable bonds with minuscule yields, when stocks are trading at modest valuations and some have decent dividends?

Unfortunately, many investors seem to be too sensitive to bad news for stocks, while ignoring the risks in bonds. Michael Carmen of Hartford Growth Opportunities (HGOAX) observed that a 5% market correction used to draw little notice from the investing public, but now triggers worried calls and redemptions.

To be sure, caution is a good thing. I heard a consensus that the economy would continue to grow but at a fairly slow pace.

In addition, most managers argued that inflation would be muted in the US, while interest rates will inevitably rise. That’s not a great scenario for investing in general, nor is it a recipe for disaster.

GMO’s Ben Inker and Ibbotson’s Peng Chen both said they are overweighting US large caps in their asset allocations. Specifically, GMO favors high-quality stocks.

BlackRock’s Dennis Stattman echoed those sentiments. He was light on bonds, and said stocks are the best game in town.

With the second quarter wrapped up, this is a good time to evaluate your portfolio. It’s always tricky to predict the effects of an action that has been telegraphed in advance, because markets try to price in that impact before it happens.

Yet, with most Treasuries paying yields lower than inflation, it’s pretty easy to see why Gross and many others are bearish on Treasuries and Treasury Inflation-Protected Securities (TIPS) alike.

If you want to dial down your Treasury exposure, and don’t have a pure government fund to dump, consider moving some or all of your money from a government-heavy intermediate-bond fund to an unconstrained bond fund, or another intermediate-bond fund that is light in Treasuries.

A more aggressive option would be a multisector-bond fund, such as Loomis Sayles Bond (LSBRX). Multisector funds tend to go after bonds with higher yields than US-government debt has.

A recurring theme of the conference was caution. So, let’s look at a few ways you can build a little more safety into your portfolio so you can weather the storm.

It’s a good idea to have some ready money to put to work when an asset class gets oversold.

For starters, there is cash in the form of money-market funds and certificates of deposit. Yes, the yields are lousy—you’re going to lose a bit of money after you factor in inflation. But the point here is to protect the downside, not to make money.

Next, there are short-term government-bond funds with low, Vanguard-esque expense ratios. Why would I touch government debt here and not in intermediate- or long-term funds? Because, in this case, the goal is to conserve money rather than earn a good return. There is less interest-rate risk, and you get a bit more yield.

That said, when some asset class does get cheap, this would be a fine area to liquidate.